The recent Supreme Court ruling in Copthorne was supposed to clear the air following a three-way split decision in the Lipson case.
Taxpayers hoped Copthorne would deliver some clarity as to how the courts should apply the GAAR.
But despite their best efforts, and detailed analysis, the Supreme Court judges appear to have failed.
They are not to be blamed for this. The problem is, by its very nature, a GAAR analysis seems to invoke a so-called “smell test”.
The Supreme Court has indicated the three facets to a GAAR analysis are: a tax benefit, an avoidance transaction, and abusive tax avoidance.
Essentially, all GAAR cases are decided on the third requirement, since the first two are usually easily proven.
Judge Rothstein openly rejected the use of moral opprobrium to decide whether the taxpayer’s actions were abusive in Copthorne and, at the same time, affirmed that the Duke of Westminster doctrine is still alive and well.
Yet there appears an irreconcilable conflict between the notion that taxpayers are entitled to plan to minimise their tax bills and the purpose of the GAAR, which is essentially designed to stop tax avoidance when all other statutes fail to protect against it.
Even if taxpayer actions follow the letter of the law, the authorities can invoke the GAAR to challenge them, and the courts must ultimately decide whether the avoidance was abusive – making it almost inevitable that a smell test will result.
In Copthorne, the non-resident shareholder invested C$97 million ($97.6 million) into the entity then tried to withdraw C$164 million without paying withholding tax.
Would the Supreme Court really have allowed the taxpayer to get away with this by saying the GAAR did not apply?
If a taxpayer like Copthorne decides to undertake an acceptable transaction – such as amalgamating to use losses – and then has two ways of carrying that out – vertical or horizontal amalgamation – then surely, if the Duke of Westminster has any meaning at all, that taxpayer should not be defeated by GAAR when it chooses the more tax effective way.
By this logic, Copthorne should have won the Supreme Court case.
The fact it did not perhaps shows that despite the clear attempt to avoid a smell test, such a test is an unavoidable component in deciding a GAAR case.
The law may well be in need of amendment, to eliminate a result that makes little tax policy sense. But as it stands, the principle established in Duke of Westminster suggests the court should have found in favour of the taxpayer.
Earlier cases such as Canada Trustco have demonstrated that the courts do have the flexibility to find the GAAR is not applicable.
However, after Copthorne, it is difficult to see how taxpayers can ever be confident that tax planning involving one or more transactions which are primarily tax-driven, will survive a GAAR challenge in future.
Copthorne’s legacy: The future of Canada’s GAAR
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